The Costs and Benefits of Shareholder Democracy

Firms with strong corporate governance are often likened to democracies. Through their proposals and votes, shareholders can determine the broad direction of a company. However, shareholder participation also exacerbates the risk that boards feel compelled to comply with a meaningless cacophony of demands by uninformed shareholders. Due to these concerns, regulators are considering measures to modify the proxy process and mitigate the costs generated by corporate gadflies (small individual shareholders).

To date, data limitations have prevented a systematic analysis of individual investor activism by shareholder-sponsored proposals. Relying on novel hand-collected data on proposal sponsors and implementation, our paper explores the effectiveness of this low-cost form of shareholder activism.

We show that the ineffectiveness of the average shareholder proposal masks large cross-sectional variation in the long-term valuation effects of proposals and is a consequence of the low cost of this type of intervention. Shareholder proposals, and in particular proposals sponsored by individual investors, may be highly beneficial because they can reach companies that are less likely to be targeted by other forms of investor activism. However, many proposals are submitted by the same few individual investors and other sponsors without organizational capabilities to analyze a large number of firms and their specific situations. These proposals if approved and subsequently implemented appear to destroy shareholder value.

We also show that the costs associated with bad shareholder proposals emerge only in companies in which shareholders do not seem to collect information before voting in the shareholder meeting. However, if a large proportion of a company’s shares are held by discerning shareholders, harmful proposals are more likely to be weeded out. We conclude that an informed shareholder base is crucial for firms to take advantage of low-cost shareholder activism and to be well-functioning democracies.